ROI and develpment assistance

This question came up in class last week: What is the return on investment from official development assistance (aid)? This is a pretty deep body of literature, and in general the results are inconclusive.

The return on aid really depends on a lot of things: the location of the recipient nation, political climate, the type of project, the savings rate of the recipient nation, etc. Aid can lead to significantly enhanced economic growth and development if conditions are right, but it also can be misappropriated, completely lost to waste and corruption and can even cause economic harm.

I found an interesting paper from two economists at the University of Copenhagen that analyzes the issue.

Dalgaard and Hansen (2005) look at micro-level ROI vs macro-level ROI to try to determine if the positive externalities from investment in growth projects such as roads, telecommunications and agricultural improvements outweigh the losses from misallocation of funds, rent-seeking etc.

In theory, if the macro ROI exceeds the micro ROI then the effects of the positive externalities outweigh the losses due to corruption etc. While micro-level ROI has recieved a great deal of attention in the econ literature, macro-level ROI apparently has not.

It's a fairly technical paper, but the main points are straightforward:

" Our principal finding is that the average aggregate gross rate of return on aid investments lies in the range 20-30 percent. Intriguingly, this is in accord with medianWorld Bank project level estimates. Moreover, aid investments are roughly as productive as domestically funded investments in physical capital.

In many ways this is an encouraging finding. It is certainly broadly consistent with the empirical work on aid effectiveness invoking ad hoc growth specifications, which tend to find that aid, on average, stimulates productivity. At the same time it is a sobering finding, since our estimates provide a sense of the limitations of aid in stimulating economic activity in poor economies."

In other words, the macro-level ROI is pretty respectable and is approximately the same as the micro-level ROI. This suggests that positive externalities and negative "leaks" balance out on average. Interestingly aid dollars produce approximately the same return as dollars invested domestically in physical capital.

A notable limitation of the study is that it does not examine the ROI on aid-based investments in human capital (i.e. education and training).

Another missing idea (one that would be useful for answering our questions from the other day) is to compare this to the ROI on investment in banks' financial stability.

But, just for giggles, according to a back-of-the-envelope look by Time magazine, the current ROI on bank bailout dollars is -1,096%.


Reference:
Dalgaard, C-J, and Hansen, H. (2005), "The Return to Foreign Aid". University of Copenhagen. Department of Economics Discussion Paper number 05-04.